FNMA 5s stealing the show again

Activity focused around the conventional 5 roll last week with the coupon attracting strong buying from just about everybody - dealers, fast money, and money managers. In mid-week comments from JPMorgan Securities, analysts noted the strength in 30-year 5s is supporting the entire MBS market. With the monthly production being bought by a "small cadre" of real money investors, these appear to be held in repo instead of rolling, analysts said, supporting the scarcity value.

Merrill Lynch analysts are advising holders of FNMA 5s to roll their securities now rather than later, "as there is still a lot of specialness in the roll and it seems too early in the cycle for the roll to trade this high."

Although not as evident, there was better buying support in most coupons last week - particularly 5.5s - as the 10-year Treasury yield continued moving higher. In addition to the real and fast money presence, overseas interest perked up with the selloff.

Originator selling remains contained, which is helping to support spreads. The large majority of issuance at this time is in 5% coupons.

Refi Index surges to near 3000

Mortgage application activity jumped over 17% for the week ending June 10, as mortgage rates dropped to their lowest level in over a year. The Mortgage Bankers Association reported that the Refinance Index surged 26% to 2967 from a seasonally adjusted 2362 versus expectations in the 2600 area. On an unadjusted basis, the Refinance Index jumped 40%. The Purchase Index, meanwhile, set a new record high at 529, up 10%. The previous record of 526 was set the week ending May 6, 2005.

"This week there was a combination of record-setting purchase activity as well as a substantial pickup in refinance applications, with the Refinance Index at its highest level since April 2004," said Michael Fratantoni, MBA senior director of single-family research and economics.

With the decline in fixed mortgage rates, as well as the curve flattening, refinancing share has been increasing. As a percentage of total application activity, refinancings increased to 46.4% from 42.9%. ARM share, meanwhile, slipped to 30.9% from 31.7%, and is down from 36.6% as of March 25. By dollar volume, ARM share is currently at 46% compared to 52% as of March 25.

Moderate increase in fixed and ARM rates

Freddie Mac reported higher mortgage rates for last week in response to this recent selloff. The 30-year fixed rate averaged 5.63%, versus 5.56% for the week ending June 10. The 15-year fixed rate was reported at 5.22%, up eight basis points; 5/1 hybrids were 5.10% versus 5.01% previously; and the one-year ARM rate increased four basis points to 4.25%. With the increase in mortgage rates, refinancings are expected to decline to the mid-2000 area from just under 3000.

"Although the 30-year mortgage rate ticked up this week, which wasn't completely unexpected, it is still below last year's annual average and well below where it was at this time last year," said Frank Nothaft, Freddie Mac vice president and chief economist.

Prepayment outlook

The current prepayment outlook sees speeds up 15% to 20% in FNMA 5s through 6s, and roughly 10% to 15% in GNMAs. In addition to the increase in refinancings impacting speeds, seasonals are higher in June and there is one extra business day included in the day count. Looking ahead to July, speeds are currently estimated to increase around 5% or slightly less from June levels as a result of the increase in refinancing activity. Limiting the increase is a lower day count - 20 versus 22 days. Revisions, however, are likely given the larger-than- expected increase in refis.